Fiscal Policy - Explaining Automatic Stabilisers
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Last updated 12 Feb 2022
This revision video covers the important role of automatic fiscal stabilisers.
In questions about fiscal policy, your analysis is strengthened by making a distinction between discretionary fiscal policy such as the furlough scheme and automatic stabilisers which kick-in when the economy moves into a slowdown or recession. Both can have important effects.
What are fiscal automatic stabilisers?
Automatic stabilisers are automatic fiscal changes as the economy moves through different stages of the business cycle – such as a fall in tax revenues from the circular flow during a recession or an increase in state welfare benefits when the unemployment rate is rising.
Automatic stabilisers during strong economic growth
- During periods of rapid economic growth (a boom phase)
- Tax revenues will rise as household real incomes and corporate profits grow – unemployment is declining
- Government welfare spending then falls as more people are in work and require less state financial support
- As a result, government finances improve including a falling budget deficit / possible fiscal surplus
- Consequently, fiscal policy is taking income out of the circular flow – automatic stabilisers help moderate a boom
Automatic stabilisers during an economic recession
- During an economic recession, real output and employment contracts
- As real incomes fall, people pay less in direct and indirect taxes and company tax payments also drop
- And government spending on welfare support such as Universal Credit increases
- Combined, this will increase the budget deficit
- A fiscal deficit is a net injection into the circular flow – thus helping to limit the depth / severity of a recession
Evaluation: How effective are automatic stabilisers in the UK economy?
- Impact depends on whether a government allows the automatic stabilisers to operate fully – and does not introduce fiscal austerity measures such as real spending cuts during a slowdown / recession
- Impact depends on the relative generosity of the welfare system such as base levels of payment for universal credit and unemployment support. Some governments have capped total welfare payments.
- Impact depends on the marginal propensity to spend and save of those households whose income is boosted by welfare during a recession